NEW YORK (CNN/Money) -
There's more trouble brewing for Connecticut hedge fund firm Bayou Securities as law enforcement officials believe hundreds of millions of dollars have gone missing from the firm, according to a report in the Wall Street Journal.

Citing a source briefed on the investigation, the Journal said that the firm's assets -- which Bayou had told investors accounted for more than $500 million last year -- had sharply declined in the last 18 months. Trading activity also dropped off.

The firm announced that it was shuttering its operations in late July. In August, investors received a letter from its founder, Samuel Israel III, promising investors that they would receive their investment back by the end of the month. But investors, who had been promised 90 percent back by mid-August, were unable to retrieve their money from two of Bayou's funds and received no response to calls placed to the firm, prompting a state and federal investigation into Bayou Securities.

A Bayou investor who called the Connecticut Banking Commission was told that the investigation was just beginning and any assets that were recovered would be a frozen, the Journal said.

The firm's disappearing act came as a surprise to investors. Israel had a solid reputation as a successful money manager and his partner, Daniel Marino, had been shopping for extra space to expand the business in April. In a letter to investors, Israel said he was closing the fund to concentrate on his children after going through a messy divorce.

But the Journal reported that much of the information Israel had provided in its marketing and investor materials regarding his own background and the firm's auditors had been misleading or out of date.

And Bayou has had previous run-ins with regulators. The Connecticut Department of Banking filed an administrative proceeding against the firm in 2003, alleging the company's records didn't accurately reflect the business it was doing, according to a report in The New York Times on Thursday.

The firm settled the proceeding, paying a $7,500 fine and agreeing to provide regulators with a list of complaints filed against it by Connecticut residents until 2005. It did not admit or deny wrongdoing, however, according to the report.

In 2003, two former employees, Paul Westerveld Jr. and his son, Paul Westerveld III, sued Israel and Marino, accusing them of possibly violating SEC regulations regarding the operation of hedge funds and claiming Bayou's management persuaded the pair to join the firm but did not provide them with necessary business documents and financial information relating to the firm, according to the Times report.

The case was dismissed from federal court in 2003 after a judge ordered the case to be heard by an NASD arbitration panel, though it was not clear an arbitration proceeding ever occurred, according to the Times.